Banking crises and Europe, our scattered band

The bankruptcy of the American technology bank SVB last weekend, and the contagion effect on the rest of the financial system, has been the second major disruptive financial event since the cost of capital ceased to be 0. It follows that budget of the English Conservative Party in September of last year that caused the need for intervention by the Bank of England. There are already two episodes that require central banks to return to the arena to rescue financial stability at a time of monetary restriction due to inflation. They exercise their role as lender of last resort.

The appearance of the European banking system, in terms of liquidity, deposits and capital, looks good —except for Credit Suisse to which the Swiss central bank has already provided liquidity. The physiology, or what’s inside, an unfinished monetary union and banking union, not so much. Let’s hope that the saying of “There are no two without three”that the following systemic number of truth —CS is not—, does not touch Europe.

These episodes occur after 15 years of unorthodox monetary policies such as asset purchases by central banks. The cost of capital has gone from zero to 3-4%, and we’ll see, very quickly. worth the analogy, so many years of monetary drunkenness requires a much longer period of adjustment than a year of market complications. To begin with, the very limitation of economic policy instruments, inherited from those excesses that in this other article we call monetary paroxysm.

In short, although deflating, sovereign debt levels at maximums, and central bank balance sheets also at maximums. At the cost of overuse, fiscal and monetary policy margins are very narrow and the options, with the existing inflation, very limited. The system’s exit from this situation is by definition going to be very hard, volatile and exposed to financial accidents, as these events have been in less than 6 months. They will not be the last.

For central banks, guarantors of financial stability, the tessitura is a true balancing act. Punctual mediation, attending episodes of financial instability such as those that have occurred, occurs at a time when the economic situation does not allow much relaxation. In both the US and Europe, the unemployment rate is at its lowest —3.6% and 6.6%— and core inflation is around 6%.

Photo: The deputy governor of the Bank of Spain, Margarita Delgado.  (EFE David Fernandez)

This is where the harshness of this period of time is portrayed: any excess in punctual intervention or delay in monetary tightening will by definition be inflationary. To the extent that these episodes of financial instability do not stop the real economy from slowing down, inflation gets bogged down and the adjustment is simply postponed. A position of rock or hard place, in the antipodes of the experience of the last decade.

The expectations of monetary easing priced in throughout the week, which reached almost one percentage point, are very premature. The ECB message on Thursday rising half a point to 3.5%, and complete uncertainty they suggest so. Other historical episodes of financial instability, such as the Mexican peso crisis in 1995, the fall of the LTCM hedge fund in 1998 or the Great Financial Crisis of 2008, they caused rates to fall, but the key difference is that inflation was not a problem at all then.

In Europe, the starting banking situation is generally better than in the US. Capital solvency ratios are almost double compared to 2008, ample liquidity and somewhat lower interest rates. But the losses in the sovereign bond portfolio are just as latent and pending possible future increases. And the dilemma between relaxing and unanchoring inflation expectations in the medium and long term is exactly the same.

Photo: Credit Suisse logo next to the Silicon Valley Bank app.  (EFE/Jim Lo Scalzo)

Institutionally, it is how Europe really limps. The lack of sufficient fixes to deal with the inconsistency of the game, a monetary union without a fiscal uniona problem that has been postponed for ten years in which political procrastination has prevailed, precisely under the protection of the ECB.

Without going any further, the American intervention this week to isolate the problem of BLS and others, part of 3 institutions: the FED, the Federal Deposits Insurance Corp (FDIC) and the US Treasury. Of all of them, Europe can only replicate with an ECB. There is neither a European Treasury nor a risk-free asset. Let’s apply a little memory and critical sense (so outdated for so long, and in recovery, in line with the cost of capital).

When the euro crisis hit, after Merkel and Sarkorzy decided that European sovereigns could effectively go bankrupt, and the German chancellor established that “never in her life” would there be a Eurobond, repudiating risk sharing, the monetary system was led to fragmentation and to the famous doom loopwhich refers to the forced dependence between national financial systems with their sovereigns. This problem was veiled with the entry into play of the ECB buying sovereign debt in March 2015a practice that officially lasted until June 2022 (except reinvestment of amortizations).

Photo: Image: Learte.

The solution to cut the “toxic link” It was designed from the ECB with the Banking Union and its 3 legs: supervision of the system from the SSM (Single Supervision Mechanism), the mechanism and resolution fund for financial institutions (SRM and SRF), and the EDIS (European Deposit Insurance Scheme).

The truth is that the last 2 chapters of that design, precisely where risk sharing is required in some format or another, were left incomplete and to be executed. Financing from the Resolution Fund (SRF) that makes backstop to the resolution of entities remained pending. The European deposit protection scheme was also left in the pipeline. They were the star issues pending execution in 2018 and 2019, when the current German Chancellor Schroeder was the Finance Minister of Merkel’s last legislature. Then came the covid crisis and the Ukraine crisis, and the focus of European public action changed.

The German reluctance to share risks in these two instances (SRF and EDIS), otherwise a recurring pattern in recent decades, with the exception of covid funds, is based on an underlying reality: “fragmentation”. That is, without resolving this, the probability that the invoice of banks in resolution falls, by peripheral banks, on the creditor North, is high. That’s where the opposition comes from. The lack of commitment suggests that the Banking Union solution, without putting Fiscal Union on track, was a highly questionable solution because it was imperfect.

Fiscal discipline must be implemented from an absent fiscal instance, a European Treasury

Paradoxically—or perhaps not so much—one risk that plagues the current predicament lies in the supervision exception given to the German Sparkassen, the small and medium-sized savings cooperatives. They are very deposit-rich institutions and probably heavily invested in German bonds; a model similar to the American SVB. According to the Bundesbank, the impact of a 2% rate hike, It can impact the portfolio of large banks by up to 6% of their own fundsbut in up to 22% in cooperatives. Eventually, a canary in the mine. It should not be stressed that any eventual activation of a national deposit mechanism would invite to shore up the doom loopthe basis of the euro crisis.

As of today, the situation of interest rates in Europe vis-à-vis the US, the liquidity and capital position of the euro financial system and its capacity to absorb losses once again grant an extension to the entire European political establishment with these delays. But we must not forget that the ECB’s balancing act to control inflation and assist financial stability, already complicated in itself, it does not have a solid institutional framework behind it.

The eventual recourse to the new monetary instrument approved last year, the monetary policy transmission mechanism to avoid “excessive fragmentation” (TPI) is of a qualitatively different order than a punctual intervention. And it would underpin the confusion between monetary and fiscal policies, the basis of the paradigm of the last decade. Sip and blow at the same time. Fiscal discipline must be implemented from an absent fiscal instance, a European Treasury.

Photo: A customer at the Silicon Valley Bank headquarters in Santa Clara, California, USA.  (Reuters/Brittany Hosea-Small) Opinion
The Silicon Valley Bank crisis and the ‘déjà vu’ trap

Marta Garcia Aller

Europe, without “risk sharing” properly speaking, it does not exist, it is simply an evocative word, a scattered band. Risk-sharing equals “permanent fiscal capacity”, the whole behind-the-scenes European political dilemma with Ukraineenergy, defense and any other heading where there is a truly European interest. In this new era of the emergence of blocks, sandwiched between the US and China, it is the instance from which everything that concerns “strategic autonomy” is effectively activated. Funding models that combine, with discipline, the federal and national levels, the Commission has several in its drawers. It is not a panacea, but it is the best option, and the cheapest insurance in the long term for everyone.

Let’s hope that the memory of those endless meetings at the wee hours of the morning at the time of the euro crisis (2010-2014), is not a deja vu. It seems that they can’t get enough of going around the wheel. And there is the saying: “There are no two without three.”

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Deborah Acker

I write epic fantasy; self-published via KDP. Devoted dog mom to my 10 yr old GSD, Shadow! DM not a priority; slow response at best #amwriting #author.

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